OCTOBER 15 2010

C. Fred Bergsten, NYT Blog: Protectionism by China Is Biggest Since World War II. China’s currency manipulation represents the largest protectionist measure maintained by any major economy since the Second World War. China has intervened in the foreign exchange markets by an average of $1 billion a day for the last five years, buying dollars to keep them expensive and selling renminbi to keep them cheap, building a gigantic reserve of $2.5 trillion in the process. Largely as a result, the renminbi is undervalued by at least 20 percent relative to economic fundamentals. The largest trading country in the world is therfore subsidizing all exports by at least 20 percent and imposing an additional tariff of at least 20 percent on all imports.

Jan Hatzius, Goldman Sachs: Thoughts on the Macroeconomic Impact of Basel III. We interpret the Basel III agreement as equivalent, very approximately, to a 5-percentage point increase in the ratio of common equity to risk-weighted assets. Our best albeit highly uncertain estimate is that this implies a cumulative drag on GDP (relative to a baseline of no regulatory change) of 2½%. Of this, we believe one-third has already occurred as banks have pushed up their common equity ratios to a level 1½ points above the average of the past two decades. But two-thirds has yet to occur, and this could imply a cumulative drag of 1½%-2% on GDP over the next few years.

John Cochrane, University of Chicago; A Big Stick for the Fed. The Fed can target the thing it cares about – expected CPI inflation – rather than the price of gold. To do it, the Fed can target the spread between TIPS (Treasury Inflation Protected Securities) and regular Treasurys, or CPI futures prices. Here’s a simple example. Investors buy a CPI-linked security from the Fed for $10. If inflation comes out to the Fed’s target, they get their money back with interest, $10.10 at 1% interest. If inflation is 2 percent below target, the Fed pays $2 extra -- $12.10. This pumps new money into the economy, with no offsetting decline in government debt, just like the helicopter drop. If inflation is 2 percent above target, investors only get back $8.10 – the Fed sucks $2 out of the economy at the end of the year. If investors think inflation will be below the Fed’s target, they buy a lot of these securities, and the Fed will print up a lot of money, and vice versa.

Neil Irwin, Washington Post: Fed weighs a more focused response. As the Federal Reserve considers what steps it might take to try to boost growth, attention has focused on whether the Fed might buy an enormous quantity of bonds to flood the economy with some specific amount of money. But there's another option that economists at the central bank are examining that has attracted little notice. Instead of just announcing that it will create, say, $500 billion out of thin air and buy bonds with the money, the Fed could instead announce it will target a certain interest rate and then buy Treasury bonds so that rates in the marketplace reach that level. For example, the Fed could announce that it aims for three-year Treasury debt that now carries an interest rate of 0.56 percent to instead be 0.25 percent. It would then buy Treasury notes in whatever amounts were needed to get rates to the target level.

Stephanie Baker, Bloombergs: Black Swan' Author Says Investors Should Sue Nobel for Crisis. Nassim Nicholas Taleb, author of “The Black Swan,” said investors who lost money in the financial crisis should sue the Swedish Central Bank for awarding the Nobel Prize to economists whose theories he said brought down the global economy. “I want to make the Nobel accountable,” Taleb said today in an interview in London. “Citizens should sue if they lost their job or business owing to the breakdown in the financial system.” Taleb said that the Nobel Prize for Economics has conferred legitimacy on risk models that caused investors’ losses and taxpayer-funded bailouts.

Mark Thoma, Money Watch: Depression Economics Needs to Become a Regular Part of Macroeconomics. How to manage the economy during severe recessions and depressions — a time when fiscal policy is generally a key component of the policy response — needs to be an integral part of the research agenda in macroeconomics, and a larger part of the curriculum at the graduate and undergraduate levels. The economics at work in depressions is distinct from the economics at other times, and hence “depression economics” is worthy of its own area within macro (Paul Krugman likes to say that “when we’re experiencing depression economics,… virtue becomes vice and prudence is folly… The trouble in practice is that conventional modes of thought tend to prevail even when they shouldn’t…”).

Ricardo J. Caballero, NBER: Macroeconomics after the Crisis: Time to Deal with the Pretense-of-Knowledge Syndrome. In this paper I argue that the current core of macroeconomics—by which I mainly mean the so-called dynamic stochastic general equilibrium approach--has become so mesmerized with its own internal logic that it has began to confuse the precision it has achieved about its own world with the precision that it has about the real one. This is dangerous for both methodological and policy reasons. On the methodology front, macroeconomic research has been in "fine-tuning" mode within the local-maximum of the dynamic stochastic general equilibrium world, when we should be in "broad-exploration" mode. We are too far from absolute truth to be so specialized and to

make the kind of confident quantitative claims that often emerge from the core. On the policy front, this confused precision creates the illusion that a minor adjustment in the standard policy framework will prevent future crises, and by doing so it leaves us overly exposed to the new and unexpected.

Guido Heineck, Bernd Süssmuth, IZA: A Different Look at Lenin's Legacy: Trust, Risk, Fairness and Cooperativeness in the Two Germanies. What are the long-term effects of Communism on economically relevant notions such as social trust? To answer this question, we use the reunification of Germany as a natural experiment and study the post-reunification trajectory of convergence with regard to individuals’ trust and risk, as well as perceived fairness and cooperativeness. Our hypotheses are derived from a model of German reunification that incorporates individual responses both to incentives and to values inherited from earlier generations as recently suggested in the literature. Using data from the German Socio-Economic Panel, we find that despite twenty years of reunification East Germans are still characterized by a persistent level of social distrust. In comparison to West Germans, they are also less inclined to see others as fair or helpful. Implied trajectories can be interpreted as evidence for the passing of cultural traits across generations and for cooperation being sustained by values rather than by ! reputation. Moreover, East Germans are found to be more risk loving than West Germans. In contrast to trust and fairness, full convergence in risk attitude is reached in recent years.

Craig James, CommSec: The iPod index. The Economist uses its Big Mac index to track the economic theory of purchasing power parity (PPP). The index works by dividing the local price of a Big Mac by the US price of a Big Mac. This gives the PPP exchange rate. If the actual exchange rate is above the PPP rate, the theory says that the currency is overvalued, and may need to fall to bring the goods in both countries in line. The problem is that Big Macs aren’t exchanged across country borders. The other problem is that the Big Mac index assumes a US base, and thus assumes that US goods are appropriately priced. When the US is used as a base for assessing PPP exchange rates, the CommSec iPod index finds that the Euro, Swiss franc, Norwegian kroner, Swedish krona and Australian dollar were over-valued against the US dollar.

N. Gregory Mankiw, NYT: I Can Afford Higher Taxes. But They’ll Make Me Work Less. HERE’S the bottom line: Without any taxes, accepting that editor’s assignment would have yielded my children an extra $10,000. With taxes, it yields only $1,000. In effect, once the entire tax system is taken into account, my family’s marginal tax rate is about 90 percent. Is it any wonder that I turn down most of the money-making opportunities I am offered?

Nicholas T. Longford, Catia Nicodemo, IZA: The Contribution of Social Transfers to the Reduction of Poverty. We interpret social transfers broadly as a set of measures to reduce or relieve poverty, and study how well this purpose is served in the countries that participated in the European Union Statistics on Income and Living Conditions in 2007. Motivated by the findings, we characterize a social transfer system in a country by its potential and effectiveness, and compare the countries for a range of definitions of the poverty threshold. In general, for any given value of the potential, the social transfers in the countries in the north and west of Europe are more effective than in the south and in the three former Soviet republics. The systems in the countries in the central Europe are about as effective as the systems in the Scandinavian countries, but have a smaller potential.

Gary Becker, Becker-Posner Blog: Incentives to Teachers and Students-Becker. Not surprisingly, teachers unions fight hardest against reforms that change the way teachers are paid, especially when they introduce incentives for teachers to perform more effectively. The disgraceful reaction of the LA teachers union to publication by the LA Times of the database that gives performance scores of the students of 6000 elementary school teachers is indicative of how teachers unions feel toward rewarding better teachers. The support by Arne Duncan, the US Secretary of Education, of the newspaper’s publication of this information is highly commendable. Not only should such information be published and publicized, but they should also be used to design a system where merit plays a sizable part in the monetary compensation of teachers.

Chris Herbst, Erdal Tekin, VoxEU: Childcare subsidies and child wellbeing. Do subsidies for childcare succeed in getting parents to work and improving the wellbeing of the children? This column presents evidence from the US suggesting that childcare subsidies have an unintended consequence. In the short run, children from low-income families are worse off as their parents go off to work and they receive low-quality childcare.